Ocean Carrier Case Study Discounted Cash Flow

Identification of the Problem

Using discounted cash flow, does it make sense for Ocean Carriers Inc to build a new ship and lease it to a customer based on the proposed conditions, and if not, under what terms would the investment make sense for Ocean Carriers?

Relevant Facts

1. Daily revenues while the ship is in operations are $20k for the first 3 years and then increases by $200 for next year and each subsequent year.

2. The operating cost is given as $4,000 per day and will increase by 1% above the inflation rate of 3%.

4. The life of the ship is 25 years.

5. Every 5 years a special survey is done which costs $300k, $350k, $750k, $850k and $1.2MM and is depreciated over the 5 years.

6. Initial working capital is $500k and will increase by inflation rate of 3%.

7. The payment for the ship is done as 10% in year 1, 10% year 2 and the remaining in year 3.

8. The salvage value of the ship at the end of 15 years is $5.0MM

Relevant Assumptions

WACC is assumed to be 10%.

Ocean Carriers scraps the ship after 15 years but in theory the ship has a life of 25 years and can be used in service for this long if the company chooses and maybe longer but there are large cap x requirements to keep it in service.

Company tax rate of 35%

Conclusion/Recommendation

The net present value of the investment for the 15 year period in which Ocean Carriers would use the ship is negative ($6,814,246) which means the company should not make the investment. In order for the investment to make sense, the company would need to get a daily rate of $24,087 under the current circumstances.

Even if Ocean Carriers kept the ship in operations for the life of the asset, 25 years, the NPV of the investment would be negative ($3,747,079) and still does not make sense under the proposed terms. If Ocean Carriers would leave the ship in operations for 25 years and then scrap it, it would need to get a daily rate of $21,774 for the investment to make sense.